Term sheets, offer letters, letters of intent, heads of agreement and preliminary agreements by any other name have become a staple part of modern M&A negotiations. However, recent developments in the law surrounding pre-contractual negotiations highlight the risk that the parties' conduct during pre-contractual negotiations can override the express provisions of a preliminary agreement.
This article will briefly examine how conduct impacts on whether preliminary agreements are legally binding, the types of liability that pre-contractual conduct can attract, and potential lessons to be learned from ongoing litigation between Archer Capital and The Sage Group plc in relation to the British technology company's withdrawal from the sale of MYOB in August 2011.
Binding contract or agreement to agree?
Preliminary agreements are often used as a starting position to provide a framework for the parties to negotiate a final contract or to record agreement on key commercial terms in order to reduce deal-risk before the parties incur any further expense. Preliminary agreements are generally expressed as being legally binding, non-binding or a mix of the two - where the parties intend certain ancillary provisions such as confidentiality, exclusivity and costs to be binding, but not the commercial terms of the transaction.
Where the parties intend the key terms of the sale contract to remain open for negotiation, it is common for preliminary agreements to be marked "subject to contract" and include a provision that the parties will negotiate to agree a definitive sale contract based on the terms in the preliminary agreement.
The High Court established in Masters v Cameron (1954) 91 CLR 353 that the words "subject to contract" in a preliminary agreement create a prima facie assumption that the parties intend that their agreement is subject to an overriding condition that the parties enter into a more substantial or formal contract based on the terms outlined in the preliminary agreement and that the preliminary agreement does not itself constitute a binding contract.
Where it can be shown that parties to a preliminary agreement intended additional terms to be included in a future contract by mutual consent, the courts have historically been reluctant to enforce such "agreements to agree" due to the inherent uncertainty of the agreed terms and the lack of a suitable remedy for breach of such agreement. However, it is now generally accepted that an agreement can be binding even though not all terms relating to the subject matter have been agreed, provided that:
- there is a sufficient degree of clarity as to the key commercial terms such that the agreement is capable of enforcement1; and
- it can objectively be shown from the surrounding circumstances that the parties intended to be immediately bound by the preliminary agreement2 rather than merely using it as a basis for further negotiations.
Where an intention to be bound can be demonstrated, courts have increasingly shown a willingness to "fill in the gaps" in preliminary agreements so that the agreement may be enforced provided that the missing terms are not so important or numerous as to make the agreement itself "incomplete"3.
Evidence of the intention of the parties is therefore a critical factor in determining whether a preliminary agreement is a binding contract or merely an "agreement to agree". Although the language used in drafting the preliminary agreement will be important in deciding this question, it is not determinative. Courts have been increasingly willing to examine the conduct of the parties as a whole both before and after the alleged agreement as a key factor in establishing the parties' intentions4.
Conduct may be considered
In deciding whether a preliminary agreement was legally binding in the recent case Factory 5 Pty Ltd (In Liq) v State of Victoria (No 2)  FCAFC 150, the full bench of the Federal Court considered the conduct and correspondence of the parties before and after execution of the purported contract (including the drinking of champagne at signing!) despite the agreement expressly stating that it was "subject to reaching agreement on a legally binding long form agreement" and subject to one party obtaining board approval.
Although the court found that the preliminary agreement was not binding as the fundamental pricing was not agreed, the overall context of the negotiations in which the preliminary agreement was made was assessed by the court including; the expiry of an exclusivity period, agreed restrictions on public announcements and evidence as to the level of negotiation around (and hence importance of) certain commercial terms.
Even where no binding preliminary agreement can be established, an aggrieved party may still bring a claim to recover loss suffered from failed negotiations under non-contractual areas of law including misleading and deceptive conduct, negligent misstatement, the tort of deceit or the equitable remedies of restitution, quantum meruit and estoppel.
Remedies based in the law of equity may not always be available to aggrieved parties due to the requirements of the jurisdiction (for example, applicants must have "clean hands" when coming before the court). However, the statutory remedies and penalties for misleading or deceptive conduct found in the Competition and Consumer Act 2010 (Cth)and the Corporations Act 2001 (Cth) will generally be available in M&A transactions and importantly, parties cannot contract out of liability for such claims.
Liability for conduct in negotiations
The conduct of pre-contractual negotiations can now be as important as the wording of preliminary agreements when deciding on their enforceability and particularly when assessing whether an aggrieved party will have access to the non-contractual remedies outlined above.
This approach may raise the eyebrows of dealmakers across the country who routinely sign up to non-binding or conditional preliminary agreements in the course of negotiations, on the basis that all the terms remain open for renegotiation until signing of the final sale contract. It also spells danger for those who "sail close to the wind" when making pre-contractual representations on the basis that liability for such statements will be "closed over" by the warranties and limitations contained in the final sale contract.
These issues go to the heart of Archer Capital's much publicised case against The Sage Group plc in relation to Sage's withdrawn offer to acquire accounting software provider MYOB from Archer in 2011.
Archer v Sage
On 16 August 2011, representatives of Archer and Sage allegedly shook hands on what Archer claims was its acceptance of a binding written offer by Sage to acquire MYOB for AU$1.35 billion. The written offer was stated to be "subject to contract" and was conditional on, among other things, review of black box due diligence material and agreement by each party's lawyers on "a small number of technical points" outstanding in the draft share sale agreement.
Sage was subsequently provided with the blackbox materials which Archer had allegedly stated would not be released until a binding agreement was made, and critically, Archer informed other bidders that their offers for MYBO had been rejected and that Archer would cease negotiations with them.
On 18 August 2011, shortly after the lawyers had agreed final changes to the draft sale agreement, Sage informed Archer that it was reducing its offer for MYOB by AU$175 million. Archer claims that Sage thereby repudiated the binding offer of AU$1.35 billion accepted by Archer on 16 August 2011.
In very general terms, Archer is seeking damages for breach of an alleged contract, equitable damages arising from an alleged estoppel and damages arising from alleged misleading or deceptive conduct on the basis that Sage had made a final binding (albeit conditional) offer for MYOB and subsequently reneged on that offer. Archer subsequently agreed to sell MYOB to Bain Capital for AU$1.045 billion in cash (together with the assumption of liabilities of AU$11 million and the provision of vendor notes with a face of AU$150 million) and is suing Sage for the difference in consideration (reportedly somewhere between AU$144 million and AU$180 million).
As part of its submissions Archer has alleged that Sage and its advisers made repeated representations that Sage had board approval for the offered price and that subject only to certain conditions (a process for satisfaction of which was included in the offer) Sage would acquire MYOB for AU$1.35 billion. Archer claims that the making of these representations was misleading and deceptive and that by releasing the blackbox material and ceasing negotiations with other bidders, Archer relied on these representations to its detriment (which is the basis of the estoppel claim).
The parties have thus far been locked in a series of interlocutory disputes including Sage's attempted discovery of information relating to the tax treatment of the proceeds of Archer's sale to Bain and Archer's discovery of correspondence between Sage and its advisers. The substantive hearings began on 25 November 2013 and are scheduled to run until late December 2013.
In addition to the question of whether the parties' conduct indicated that Sage's conditional offer was intended to be final and binding, the case raises interesting questions in relation to when a vendor may feel comfortable in releasing its blackbox due diligence material and the impact and admissibility of correspondence between financial advisers in the formation of legal obligations between parties.
Regardless of the outcome of the case, the dispute is a reminder to all in the M&A industry that the context in which preliminary agreements are made and the conduct of negotiations, including representations made by advisers, may be examined by the courts when considering a claim for misleading and deceptive conduct or when considering whether a preliminary agreement is binding despite the parties' agreement that their negotiations are "subject to contract".
- "Agreements to agree" may in fact be enforceable contracts depending on the materiality of outstanding points and the intentions of the parties (which will be objectively assessed).
- Be careful in the conduct of negotiations. You can't contract out of liability for misleading and deceptive conduct.
- If parties intend that all the commercial terms outlined in the preliminary agreement are not binding and remain open to re-negotiation until a formal sale contract is signed, then this should be expressly stated in the preliminary agreement.
- If parties intend a preliminary agreement to be binding, it should be expressly stated in the document and if any additional terms will need to be agreed in the final form contract, the preliminary agreement should contain a clear mechanism for resolution of these points.
1Coal Cliff Collieries v Sijehama (1991) 24 NSWLR
2GR Securities P/L v Baulkham Hills Private Hospital P/L (1986) 40 NSWLR 631 at 634E cited in Bagot v Chameleon Mining NL  NSWSC 1331 at 
3Factory 5 Pty Ltd (In Liq) v State of Victoria (No 2)  FCAFC 150 at 
4Factory 5 Pty Ltd (In Liq) v State of Victoria (No 2)  FCAFC 150
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.